Organic Grocers Are Losing Their Cool

Danny Johnston/AP
The first week of May wasn't a good one for shareholders of Whole Foods Market (WFM) and Sprouts Farmers Market (SFM), with the stocks tumbling 12 percent and 14 percent, respectively. The two supermarket chains specializing in organic edibles stumbled after posting disappointing quarterly results.

Store-level growth is decelerating at the two grocers, and things have gotten to the point where niche leader Whole Foods is ready to roll out a new concept offering cheaper organic merchandise. It wants to appeal to millennials, who don't seem to have the same interest in paying a premium over traditional nonorganic items as the older shoppers who frequent the namesake chain.

Was going organic merely a trend and not a movement? Are the specialty supermarkets simply feeling the pinch of conventional supermarkets and discount department-store chains hopping on the bandwagon? Are you going to eat that wheat germ-dusted soy yogurt or can I have it?

Organic at the Disco

Consumers don't have it as hard as investors do in this market. Whole Foods was a fast-growing market darling until a couple of years ago. The stock has shed more than half of its value since peaking three years ago. Sprouts was a hot IPO two years ago, but the stock has shed a quarter of its value since closing just north of $40 on its first day of trading.

The downward-sloping stock charts suggest that popularity is waning, but that's not necessarily the case. Sales at the typical Whole Foods rose a currency-adjusted 3.6 percent during the first three months of this year when pitted against the prior year's sales. Sprouts is holding up even better, with comparable-store sales up 4.8 percent over the past year. That's not bad, but both stocks still got rocked because they were growing a lot faster in previous quarters.

Things only got worse on the way down to the bottom line. Both chains experienced a year-over-year decline in gross margins. Both companies point to rising produce costs as the culprit, but the real story here is that Whole Foods and Sprouts didn't have the flexibility to pass on the entirety of those increases to shoppers. That's a problem for them, but an opportunity for consumers. The market for organic groceries is getting more competitive as Walmart (WMT) and mainstream supermarkets are starting to stock their shelves with more organic foodstuffs.

Half Foods Market

Whole Foods has 417 stores out there, and it sees the potential for 1,200 locations in the U.S. alone. This is the kind of goal-oriented news that assures investors that there's still plenty of expansion left. After all, we're just a little more than a third of the way into the growth story. Sprouts has less than half as many stores as Whole Foods, so it has even more real estate left to conquer -- in theory.

However, Whole Foods dropped a preservatives-free bombshell on the market last week by announcing that it would be opening smaller and cheaper stores in the future.

"We are excited to announce the launch of a new, uniquely-branded store concept unlike anything that currently exists in the marketplace," co-CEO Walter Robb is quoted as saying in this month's earnings release. "Offering our industry-leading standards at value prices, this new format will feature a modern, streamlined design, innovative technology and a curated selection. It will deliver a convenient, transparent, and values-oriented experience geared toward millennial shoppers, while appealing to anyone looking for high-quality fresh food at great prices."

The market didn't applaud the news, judging by the sinking stock after the announcement. If Whole Foods opens up a sister concept offering better prices on organic items, why would just millennials start shopping there? A year ago we saw Walmart turn heads by vowing to slash prices on its private-label organic foods. The thinking at the time was that Whole Foods would be immune since it's an entirely different clientele that it's ringing up, but this move suggests that it's feeling the pressure to compete at the lower end of the market. In short, the organic specialists are no longer that special.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. Is your portfolio ready for what this year has to offer? Click here to check out our free report for one great stock to buy for 2015 and beyond.